* Shares down 42 pct after dividend also scrapped
* Rights issue planned for up to 700 million pounds
* Group cuts 2018 profit forecast by around 30 percent (Adds British government comment)
LONDON, Jan 31 (Reuters) - British outsourcing group Capita lost 40 percent of its market value on Wednesday after its new boss slashed profit forecasts and set out plans to raise cash to avoid the same fate as collapsed rival Carillion.
Just two weeks after Carillion perished under a pile of debt, Capita, which provides IT services to companies and governments to cut costs, said it needed a complete overhaul and to retrench.
The company cut its 2018 profit forecast by 30 percent only seven weeks after reiterating it following a string of warnings last year.
Under new Chief Executive Jonathan Lewis who arrived in December, Capita said it would raise around 700 million pounds ($992 million) in a rights issue in 2018, scrap the dividend and sell assets to enable it to boost investment, focus on contract profitability, and plug a hole in its pensions scheme.
Capita's shares were down 42 percent at 1338 GMT, wiping 970 million pounds off its market value and leaving the stock down 85 percent since mid-2015. The shares were trading at levels last seen in 2003.
"Capita needs to change its approach," said Lewis.
"We cannot continue to focus on the incredibly broad array of disparate businesses. The strategic review we're undertaking will cause Capita to shrink, cause Capita to focus."
Like Carillion, Capita provides vital services in Britain from running the system that pays National Health Service dentists to hospital triage support, collecting the congestion charge for driving in central London and helping retailers manage online shopping sites.
It employs 73,000 people and operates primarily in Britain over hundreds of separate contracts.
The news sent shockwaves through a sector still reverberating from Carillion's demise on Jan. 15.
Britain's main opposition Labour Party called for the government to take steps to oversee Capita, a major beneficiary of public sector contracts. "We cannot afford another Carillion," lawmaker Jon Trickett said.
A government spokesman told reporters it was monitoring the health of suppliers: "We do not believe that any of our strategic suppliers including Capita are in a comparable position to Carillion."
Carillion, which built large infrastructure projects, was largely brought down by problems on a number of its construction contracts and not the day-to-day provision of services.
Capita did not specify which contracts were problematic but pointed to a lower number of new ones being awarded for smaller amounts, in a more sluggish business operating environment.
British outsourcing has grown rapidly since the 1980s and is now dominated by giants such as G4S, Serco, Capita and Mitie who employ hundreds of thousands of staff to provide services to the public and private sector.
Many were hit after they took on work at wafer-thin margins during the financial downturn, leaving little room for error. Uncertainty over Britain's departure from the European Union has compounded the sector's problems.
Analysts warned of a long road back to recovery for Capita, but welcomed swift action from its new boss.
"Similarities with Carillion are all too clear but action, however painful, is better than fudging numbers," said Neil Wilson, senior market analyst at ETX Capital.
Capita's problems were sown over a long period, said Lewis, who has a reputation for turning around firms, such as oil services company Amec Foster Wheeler, where he cut costs to boost profitability.
"Capita has underinvested in the business and there has been too much emphasis on acquisitions to drive growth," he said.
"An immediate priority is to strengthen the balance sheet through a combination of cost savings, non-core disposals and new equity."
Capita said underlying pretax profit, before significant new contracts and restructuring costs, was expected to be between 270 million and 300 million pounds, compared with analysts' average forecast of 406 million, according to Reuters data.
It forecast net debt at the 2017 year-end at around 1.15 billion pounds. The dividend would be suspended until the company generated sustainable free cash flow.
The firm is also undertaking a triennial review of its pension scheme. Its current expectation is that the actuarial deficit will be significantly below the last disclosed deficit of 381 million pounds as at June 30, 2017.
"We will seek to reduce the remaining deficit as a priority," it said.
($1 = 0.7051 pounds)
(Reporting by Elisabeth O'Leary and Kate Holton; Editing by Alison Williams and Mark Potter)